Multiple Choice
In the context of externalities, what is the typical effect of free trade among countries on the prices of goods?
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7. Externalities
Externalities: Social Benefits and Social Costs
Multiple Choice
Crowding out is most likely to occur with which of the following changes?
A
A reduction in negative externalities through the imposition of a Pigovian tax
B
A decrease in government regulation that encourages more private sector activity
C
An increase in subsidies for goods with positive externalities
D
An increase in government spending that leads to higher interest rates and reduced private investment
Verified step by step guidance1
Step 1: Understand the concept of crowding out. Crowding out occurs when increased government spending leads to higher interest rates, which then reduces private investment spending.
Step 2: Analyze each option in terms of its effect on government spending and private investment. For example, a Pigovian tax reduces negative externalities but does not necessarily increase government spending or interest rates.
Step 3: Recognize that a decrease in government regulation encouraging private sector activity typically promotes private investment rather than crowding it out.
Step 4: Consider that increasing subsidies for goods with positive externalities involves government spending but usually aims to complement private investment, not reduce it.
Step 5: Identify that an increase in government spending can raise demand for loanable funds, pushing up interest rates and thereby reducing private investment, which is the classic scenario for crowding out.
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